Fault Lines: How Hidden Fractures Still Threaten the World

In his book, “Fault Lines: How Hidden Fractures Still Threaten the World”, Raghuram G. Rajan identified two main fault lines in the global economy. Firstly, the willingness to supply credit to those who had not benefitted from rising GDP. He says, “the political response to rising inequality—whether carefully planned or an unpremeditated reaction to constituent demands—was to expand lending to households, especially low-income ones. The benefits—growing consumption and more jobs—were immediate, whereas paying the inevitable bill could be postponed into the future.”[1]

The second fault line he saw in the global economy, agreeing with Michael Pettis, was that the export-lead policies of countries like Germany, Japan and China, created significant trade imbalances, supplying consumer demand in deficit countries. As regards the impact of uncontrolled credit, which Rajan saw as a major cause of the 2007/2008 Great Financial Crisis, he said, “an enormous quantity of money flowed into low-income housing in the United States, both from abroad and from government-sponsored mortgage agencies such as Fannie Mae and Freddie Mac. This led to both unsustainable house price increases and a steady deterioration in the quality of mortgage loans made.”[2] It is also clear that the investment banks packaged these subprime housing mortgages as highly rated investments and that these toxic debts undermined the credibility of the financial markets. As Rajan argued, the underlying cause of cheap consumer credit in the United States was the political need to counter the effects of increasing inequality, which had resulted in a lack of growth in wages for the average American. He also warned of the consequences of failing to deal with inequality, “Deep imbalances such as inequality can create the political groundswell that can overcome any constraining institutions. Countries can return to developing-country status if their politics become imbalanced, no matter how well developed their institutions.”[3]